November 2017 The European Commission’s Expert Group on Corporate Bond Markets recommends that the implementation of the proposed CSDR mandatory buy-in regime be delayed in order to review its provisions. The recommendation is one of 22 put forward by the industry group in its report, Improving European Corporate Bond Markets, intended to improve the efficiency and functioning of the European corporate bond markets. The potential risks to market stability stemming from the mandatory buy-in provisions are discussed further in the Expert Group’s accompanying report, Analysis of European Corporate Bond Markets.

According to the Expert Group’s headline report:

“Currently, the regulation on settlement and central securities depositories (CSDR) requires market participants having failed to receive a security to initiate a buy-in process. This creates risks for liquidity providers, investors and securities lenders, and has a negative impact on market efficiency and stability. Therefore, the timing for the implementation of CSDR mandatory buy-ins should be carefully managed to cushion its impact and provide space to review the provisions before they have unintended and potentially irreversible consequences.”

As of January 2018 the European Commission was still reviewing the draft RTS for CSDR mandatory buy-ins (published in February 2016 – see below). ESMA has proposed a 24 month implementation period once the RTS is finally passed into law.

May 2017 ICMA publishes a Position Paper on CSDR Settlement Discipline. The paper was prepared in close consultation with the SMPC CSDR/Buy-in Working Group, as well as with the SMPC, ERCC, and AMIC. Essentially, ICMA proposes that the cash penalties for bonds should be increased when implemented in 2019, while mandatory buy-ins should not be implemented.

ICMA’s position can be summarized as:

ICMA broadly supports the proposed cash penalty mechanism for settlement fails, although it argues that an appropriate calibration of the penalty rates is an essential consideration in its design.

ICMA retains its firm opposition to the mandatory buy-in regime, which it argues is fundamentally flawed and will be detrimental to bond market stability and liquidity.

ICMA proposes that the cash penalty regime be implemented as scheduled, with a higher than proposed penalty rate for bonds. However, the mandatory buy-in regime should not be implemented as scheduled.

The proposed penalty rate for ALL bonds (except SME debt instruments) should be the equivalent of 2.50% annualized.

The mandatory buy-in regime should only be implemented as a ‘last resort’ following an assessment of the impact of the penalty mechanism, and other initiatives, on bond market settlement efficiency rates.

The Position Paper can be downloaded here.March 10 2017 A package of regulatory technical standards (RTS) for CSDR was published in the Official Journal of the European Union. This included the RTS for the parameters for the calculation of cash penalties for settlement fails and the operations of CSDs [central securities depositories] in host Member States. The specific RTS relating to cash penalties can be found here.

The regulatory initiative is a key component of CSDR’s framework for Settlement Discipline, as outlined in Article 7 of the 2014 CSDR, alongside the requirement for CSDs and CCPs to monitor and report participants that consistently systematically fail transactions (‘name and shame’), and a mandatory buy-in regime. The objective of the cash penalties regime is to create a standardized, harmonized penalty regime across the EU to be applied in the event of settlement fails.

The full CSDR Settlement Discipline package (including cash penalties and mandatory buy-ins) is expected to be implemented no earlier than June 2019.

An ICMA briefing note outlining the background, details, and potential impacts of the cash penalty regime can be found here.

March 2017 ICMA writes to Olivier Guersent (Director General of DG-FISMA) and Steven Maijoor (Chair of ESMA) informing them of changes to the ICMA ‘buy-in rules’. In light of the consultation that precipitated and informed the update to the ICMA secondary market rules and recommendations buy-in procedure, ICMA also highlights to the Commission and ESMA its concerns with respect to the projected implementation of the mandatory buy-in regime under CSDR.Letter to Olivier GuersentLetter to Steven Maijoor

March 2016 ICMA publishes a paper illustrating the problems arising from an asymmetry in the proposed CSDR mandatory buy-in process that only allows for the settlement of the buy-in or cash compensation price differential to be paid in one direction. Conventional buy-in processes, such as under ICMA Rules, allow for the payment of the buy-in differential to be paid in either direction between the buyer and seller, depending on whether the buy-in price is higher or lower than the original trade price. This ensures an equitable remedy, with neither the buyer or seller incurring an undue profit or loss as a result of the buy-in. The CSDR buy-in process, however, only allows for the payment to be made by the seller to the buyer in the event that the buy-in price (or cash compensation reference price) is higher than the original trade price. From a risk perspective, this asymmetry is the equivalent of any seller of securities also writing a free at-the-money put option which will become active in the event of a buy-in. Conversely, any purchaser of securities will be long this free option.

ICMA is hopeful that ESMA and the European Commission will address this highly technical, but fundamental, anomaly before attempting implementation of the mandatory buy-in regime, currently projected for early 2019.

Since the publication of the Level 1 draft text of CSDR Regulation, ICMA has been highly engaged in cross-industry advocacy related to the Regulation’s provisions for settlement discipline, in particular mandatory buy-ins, which is broadly recognised as having a potentially detrimental impact on European bond and repo market liquidity and efficiency.

1 February 2016 ESMA published the long-awaited draft RTS for mandatory buy-ins. Given the restrictions of the Level 1 text, and the concerns raised by earlier draft RTS, the final draft RTS attempt to strike a balance between consistency with the intent of the Regulation and minimizing the potential for unintended adverse impacts to European capital markets.

Accordingly, EMSA has proposed what is essentially a trading level buy-in process, and so limiting (though not fully negating) risks to CSD participants (essentially custodian and agent banks). Furthermore, within the restrictions of the Regulation, ESMA proposes the longest possible extension period (i.e. the duration of the fail before a buy-in is initiated) of seven business days for all fixed income securities. With respect to securities financing transactions, which, are also brought in scope of the Regulation, ESMA proposes an exemption for any SFTs with a term of less than 30 business days. This exemption appears to apply to both start- and end-legs.

There remains an issue relating to an asymmetric treatment of the payment of the differential between the buy-in or cash compensation reference price and the original trade price, which ICMA will continue to discuss with the authorities.

6 August 2015 ICMA has submitted its response to the ESMA Consultation Paper for Regulatory Technical Standards on the CSD Regulation related to the Operation of the Buy-in Process. ICMA has consistently advocated against a mandatory buy-in regime, which is broadly recognized as being detrimental to European bond and repo market stability, efficiency, and liquidity, as well as creating significant risks and costs for investors, trading counterparties, settlement agents, and settlement systems themselves.

The purpose of this ESMA Consultation Paper is to seek stakeholder input on the technical standards (the ‘Level 2’) for the process of the buy-in under the mandatory regime. In its response, ICMA has gone to great lengths to argue that any buy-in process, if implemented, should only be at the trading counterparty level, and not at the CSD participant level. This is wholly in line with the market-wide consensus. However, even with a trading level process, ICMA carefully outlines the challenges, risks, and inconsistencies, many of which are the direct result of the widely recognized flaws in the Level 1 Regulation. Furthermore, ICMA uses this response as another opportunity to recommend a practical delay in the implementation of the regime, ideally until post T2S (2018).

Buy-ins, how they work, and the challenge of CSDRAn ICMA briefing note

July 2015 As ICMA prepared its response to the ESMA Consultation Paper on the CSDR regulatory technical standards related to the operation of buy-in, it published a Briefing Note on the buy-in process. The paper illustrates how buy-ins work currently, and how they are proposed to work under CSDR. While CSDR does not define what a buy-in is, or what it is intended to do, it does provide for who should be responsible for, and be affected by, a buy-in, as well as the related cash-flows.

24 February 2015 The inclusion of a mandatory buy-in regime in CSD Regulation has been highly contentious, and many market participants question whether it can improve settlement efficiency. The ICMA study illustrates that if, or when, mandatory buy-in regulation is implemented (scheduled for early 2016), liquidity across secondary European bond and financing markets will reduce significantly, while bid-offer spreads will widen dramatically. The results suggest that even the most liquid sovereign bonds will see bid-offer spreads double, while secondary markets in less liquid corporate bonds may effectively close. The survey further suggests that for many less liquid bonds, including sovereign and public issues, market-makers will retrench from providing liquidity altogether.

The study also highlights the potential costs of these impacts, that will be borne by investors and issuers (public and private), and so constitute a cost to the real economy.

19 February 2015 ICMA has submitted its formal response to the ESMA Consultation Papers on Technical Standards and Technical Advice under the CSD Regulation. ICMA’s response focuses primarily on Settlement Discipline, which will have the most direct impact on the functioning and efficiency of the European capital markets. Of particular concern to ICMA’s members is the provision for Mandatory Buy-ins. In responding to the various questions, ICMA provides a number of recommendations to support the successful implementation of Settlement Discipline measures, as well as suggested enhancements to the draft technical standards.

November 2017 The European Commission’s Expert Group on Corporate Bond Markets recommends that the implementation of the proposed CSDR mandatory buy-in regime be delayed in order to review its provisions. The recommendation is one of 22 put forward by the industry group in its report, Improving European Corporate Bond Markets, intended to improve the efficiency and functioning of the European corporate bond markets. The potential risks to market stability stemming from the mandatory buy-in provisions are discussed further in the Expert Group’s accompanying report, Analysis of European Corporate Bond Markets.

According to the Expert Group’s headline report:

“Currently, the regulation on settlement and central securities depositories (CSDR) requires market participants having failed to deliver a security to initiate a buy-in process. This creates risks for liquidity providers, investors and securities lenders, and has a negative impact on market efficiency and stability. Therefore, the timing for the implementation of CSDR mandatory buy-ins should be carefully managed to cushion its impact and provide space to review the provisions before they have unintended and potentially irreversible consequences.”

As of January 2018 the European Commission was still reviewing the draft RTS for CSDR mandatory buy-ins (published in February 2016 – see below). ESMA has proposed a 24 month implementation period once the RTS is finally passed into law.